Is AT&T still a great dividend?
With an agreement to merge WarnerMedia with Discovery (NASDAQ: DISCA)(NASDAQ: DISC), telecoms giant AT&T (NYSE: T) made an expensive round trip in and out of the media industry. AT&T bought satellite TV provider DIRECTV under a $ 49 billion deal in 2014, followed a few years later with an $ 85 billion deal for Time Warner. At the time the Time Warner deal was struck, AT&T had a whopping $ 180 billion in debt on its balance sheet.
The acquisition of DIRECTV was an absolute disaster. The company lost pay-TV subscribers for years before finally selling a minority stake in the business at a valuation well below what it paid for. The acquisition of Time Warner brought valuable strengths to AT&T, including HBO, but the combination of the two companies has never made more sense.
The deal with Discovery will transform AT&T into a telecommunications company. AT&T will receive $ 43 billion in cash, debt and debt retention from WarnerMedia, while AT&T shareholders will own 71% of the new media company.
By 2023, the new media company is expected to generate revenue of $ 52 billion and free cash flow of approximately $ 8 billion. This is good news for AT&T shareholders. The bad news for AT&T shareholders is that AT&T is taking this opportunity to significantly reduce its dividend.
A big reduction in the dividend
Telecommunications stocks have traditionally been big dividend payers. AT & T’s dividend yield currently stands at around 7%. Even though the stock hasn’t gone anywhere in years, this high dividend yield offers investors a good return.
This high dividend has been weakened by the massive amount of debt on AT&T’s balance sheet. The WarnerMedia deal will allow AT&T to reduce its debt, but the company is going even further to make the dividend more sustainable.
AT&T expects to produce annual free cash flow of approximately $ 20 billion once the transaction is completed. The company is aiming for a dividend payout ratio of 40% to 43%, so that $ 8.6 billion will go towards paying dividends. This compares to over $ 15 billion in dividend payments in 2020.
In other words, AT&T shareholders are going to take somewhere between a 40% and 50% dividend cut. At the current share price, AT & T’s dividend yield would drop to around 3.5% or 4%, depending on the final decision.
Still a solid dividend
While shareholders will receive less money from AT&T each year, the story is now much simpler. AT&T will be a telecommunications company and the dividend cut will free up cash for investments in 5G and fiber broadband. Share buybacks are also on the table once AT&T reduces its debt sufficiently. The company will consider share buybacks once its net debt to adjusted EBTIDA ratio drops below 2.5, which is expected to occur by the end of 2023.
Since AT&T is currently trading for less than 10 times its free cash flow, share buybacks make a lot of sense. A huge dividend is good, but it may not be the optimal way to return capital to shareholders if valuation remains low.
And of course AT&T shareholders will own a piece of a media and streaming giant that’s more capable of taking Netflix and Disney. Once the deal is closed, AT&T shareholders will own one strong dividend plus one growth share. It doesn’t seem like a bad deal to me.
It would have been better for the shareholders if AT&T had never tried to build a media empire. But given the company’s current situation, this deal is the right move. AT&T will be a simpler company with a smaller dividend, but it may turn out to be a better long-term investment than the complicated, fragile, high-yielding mess of the past few years.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.